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The EU debt crisis: Is Portugal the final chapter?

By
Wen-Dar Chen, Graham McDevitt

May 10, 2011

The following information is based on market circumstances as of the date indicated.

On April 7, 2011, Portugal formally requested bailout funds from the European Union (EU) and the International Monetary Fund (IMF). The news didn't seem to unnerve investors, primarily because the bailout request had been expected for some weeks.

Less than 24 hours later, the European Central Bank (ECB) raised rates by 0.25 percentage points, an action that reflected its sole mandate: to maintain price stability within the euro zone. The tone expressed by the ECB at the time of the announcement (and in subsequent weeks) has apparently validated the market's current discounting of at least two more rate increases later this year.

Here are several points we're keeping in mind in light of Portugal's bailout bid:

A sovereign debt crisis is not a new phenomenon. What we feel is unique about today's situation, however, is that it's happening within the confines of a single currency. This straitjacket puts a limit on policy options, leaving governments with few avenues to pursue when resolving debt crises. Given that the euro has recovered to pre-Greek-crisis levels, certain sovereigns are being pressured even more — forcing them to impose massive fiscal austerity on their populations.

Portugal's case is different from Greece's and Ireland's.
The bailout packages of Greece and Ireland have different dimensions, primarily because the two countries are dealing with different kinds of financial stress. Greece's package is based on the requirement that Greece reform its public sector and pension system while agreeing to additional fiscal measures to reduce its budget deficit dramatically by the end of 2014. Ireland's package, meanwhile, is primarily directed toward recapitalizing and restructuring the country's
banking sector. Portugal's circumstance has its own particular variation; economic data suggest the country exhibits a less-competitive economic model, higher costs of production, a current account that is continuously in deficit, and a low savings rate compared with the core European countries.

We believe Portugal is not the final chapter of the sovereign debt crises. Spain, for instance, is another country that is under scrutiny. Analysts are concerned about weaknesses that include an undercapitalized banking sector, a rising budget deficit, high unemployment, and weak economic growth. The Spanish government began taking proactive steps last year, including steps to implement social reforms and apply austerity measures. Nonetheless, it would appear that the pressure on Spain is expected to persist in the second half of 2011, as more than 45 billion euros of government debt comes due.

Important update as of May 10, 2011 — The past week has witnessed another leg in the EU crisis, with official recognition that Greece's bailout package will probably not be enough. The massive austerity measures undertaken in Greece have caused public consumption to collapse. This, combined with the cost of financing a debt level that has reached 140% of gross domestic product, is resulting in painful consequences for the country.

Markets are expecting additional EU support of at least 30-60 billion euros to be announced in the very near term. More importantly, financial markets now expect some form of Greek debt restructuring during 2011. The euro has fallen and spreads have widened. A Greek restructuring event, while now largely expected, is likely to have negative implications for spread markets as concern will shift to the sustainability of the EU banking system and other sovereigns like Portugal and Ireland. We remain on alert.

(Data: Bloomberg.)

The views expressed were current as of May 10, 2011, and are subject to change at any time.

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More from Wen-Dar Chen

Wen-Dar Chen biography

Wen-Dar Chen, Ph.D.

Senior Vice President, Senior Portfolio Manager and Analyst

Wen-Dar Chen, Ph.D., is a member of the firm’s taxable fixed income portfolio management team with primary responsibility for constructing global investment themes, international portfolio strategic asset allocation, and risk management. He has specialized in quantitative fixed income investments since 1986. Before he joined Macquarie Investment Management (MIM), which includes the former Delaware Investments, in mid-2004 as a senior international debt analyst, he was a quantitative analyst in global asset-backed securities, credit strategies, and portfolio strategies at J.P. Morgan Securities. Since 1998, he has worked to promote the asset-backed securities business in Asia, and published the book, Asset-Backed Securitization – Theory and Practice, in Asia in 2002. He worked at Salomon Brothers from 1993 to 1996, and Lehman Brothers from 1990 to 1993, during which time he gained experience with government securities trading desks, proprietary trading of structured products, financial strategies, and index strategies groups. Dr. Chen’s degrees include a bachelor’s degree in atmospheric sciences from the National Taiwan University, a master’s degree in meteorology from the South Dakota School of Mines and Technology, and a Ph.D. in geophysical fluid dynamics from Princeton University.

Graham McDevitt biography

Graham McDevitt

Global Strategist — Macquarie Bank International Limited

Graham McDevitt is a member of the investment team of Macquarie Investment Management and formerly managed Delaware International Bond Fund from July 2011 until July 2012 as a senior portfolio manager at Delaware Investments prior to joining MBIL. He is head of global strategy for Macquarie’s Fixed Income and Currency Division where he is responsible for global sector rotation across a number of funds. McDevitt has over 25 years experience as an economist and global strategist, including 16 years in London. Prior to joining Macquarie Group in 2007, he spent eight years in various senior positions at ABN Amro, including global head of interest rate strategy, global head of credit research, and more recently, global head of financial market research, covering interest rates, currencies, and credit. In this role he managed a 90-member research team in the United Kingdom, Europe, the United States, and Australia. McDevitt holds a Master of Commerce, major in economics, from the University of New South Wales, located in Sydney, Australia.

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